Credit Culture: Incentivizing Greed and Irresponsibility

Credit Culture: Incentivizing Greed and Irresponsibility
Ken Connor
Sunday, February 28, 2010

On February 22, 2010, nine months after President Obama signed the legislation, new credit card rules designed to protect consumers from the unscrupulous and manipulative tactics of credit card companies went into effect. The legislative momentum that led to the passage of the Credit Card Accountability, Responsibility, and Disclosure Act (Credit CARD) has been building for years, and was thrown into overdrive by the economic meltdown of 2008. Countless Americans who felt they had been duped by greedy mortgage brokers and cheated by reckless Wall Street fat cats were only too happy at the prospect of throwing the legislative book at the corporate moguls who profit from our nation’s dependency on credit cards.

And throw the book we did.

Designed to put an end to many of the predatory practices that cost consumers up to $15 billion in late fees and other penalties each year, the Credit CARD Act will free millions of credit card users from retroactive interest rate increases on existing card balances and will give them more time to pay their monthly bills, greater advance notice of changes in credit card terms, and the right to opt out of significant changes in terms on their accounts. Senator Chris Dodd, the author of the Credit CARD Act, celebrated the passage of the new law:

“Gone are the days of gouging hardworking families with ‘any time, any reason’ rate increases and unreasonable fees and penalties. With the signing of this bill, President Obama has ushered in a new era where consumer protections will be strong and reliable, rules transparent and fair, and statements clear and informative . . . Today is the day we finally make credit card companies accountable to their customers and responsible for their actions.”

There’s no denying that credit card companies have employed shady tactics in pursuit of maximizing profits. And, much like their brethren at the big banks and on Wall Street, their failure to behave ethically has given the government an excuse to interfere in yet another corner of the free market. It didn’t take long, however, for consumer advocacy groups and others to point out that, in addition to making it more difficult for card companies to gouge their customers, the Credit CARD Act will make it a lot more difficult and a lot more expensive for everyday Americans to get, and keep, a credit card.

In short, since credit card companies are no longer able to pad their profits by exploiting those least capable of managing their credit responsibly, the companies are going to have to adjust their business and marketing model to reflect this new reality. This includes restricting the amount of business they are willing to do with “risky” customers. For the first time in years, sub-prime borrowers, college students, and other “vulnerable” segments of society will find their access to easy credit significantly curtailed.

While some may view this as an unjust response on the part of the credit card companies, responsible measures that push Americans to break their addiction to credit cards are a good thing. As a nation and as individuals, we’ve gotten to the point where we can hardly conceive of living life without access to an endless line of credit. Convinced that we can “have it all and have it now,” we’ve leveraged ourselves to the hilt, financing our food, clothing, shelter, transportation, entertainment – heck, even our government – with credit!

Not surprisingly, our lenders recognize the power they have over us and have used that power to keep us in bondage. This is not something new. The Old Testament Book of Proverbs cautions against the kind of recklessness and greed that leads to financial indebtedness, reminding us that “the rich rules over the poor, and the borrower is the slave of the lender.”

The average American – identified by the multiple credit cards in his wallet, the home mortgaged thrice-over, and the two cars in the driveway being paid for “on time” – has ignored the wisdom of these words for far too long, and the credit card companies have profited hand over fist.

For the time being, it appears that the playing field has been leveled. Because credit card companies are no longer permitted to load up the fine print with predatory and exploitative terms, irresponsible and ignorant consumers will be forced to reduce their dependency on credit as a means of living beyond their means.

It will be a painful lesson for consumers, but one we’re desperately in need of learning.
______________________________________________________________
Good Intentions Do Not Always Make for Good Results
Sarah Longwell
Monday, March 01, 2010

Senator Chris Dodd (D-CT) is likely to unveil highly-anticipated financial reform legislation in the coming week. This news comes a few days after Republican Senator Bob Corker announced his plan to partner with Dodd on financial reform. Until that point, the two political parties had been unable to see eye-to-eye on this topic. A bi-partisan agreement would likely include stronger government oversight of Wall Street, but not a new financial protection agency for consumers (a sticking point for Senator Corker).

But in their efforts to hammer out a compromise and gird our country against future financial crises, our representatives should be mindful of the history of unintended consequences that resulted from poorly thought-out government financial intervention.

One consequence reared its head late last year, following the passage of the Credit CARD Act of 2009. Among other provisions, this legislation placed limits on the fees that some card providers could charge to their customers, capping them at 25 percent of the card’s total credit line. Fees like this were targeted because they were considerably higher than normal card fees, and sometimes “hidden” in the small print of a card’s agreement.

Congress’ actions may sound reasonable, until you consider that many consumers with poor credit histories relied on these high-fee cards as their only source of credit.

For the majority of Americans who don’t have a spotty credit history, getting a credit line with few fees attached is no big deal. However, for those who have made poor spending decisions in the past, a card provider generally charges a higher up-front fee to compensate for the higher risk that the borrower will skip out on the bill.

But with those fees capped, the card companies have two options: they can stop providing cards to customers with lower credit scores, or they can raise interest rates. One card issuer, called First Premier, chose the latter option: they lowered their annual fee to $75 (from a previous $256), and raised interest rates to an unheard-of 79.9 percent. That’s nearly seven times the APR of an average credit card.

Some news stories blamed First Premier for bilking consumers, but this ire is misdirected. A credit company can’t remain in business long if they’re always lending and never being repaid. Whether it’s through higher fees or higher interest rates, the company has to be compensated for the greater risk of lending to those with poor credit histories. And if well-intentioned legislators decided to cap both fees and rates, companies like First Premier would find themselves out of business – and many Americans would find themselves out of any credit at all.

You can see another example of regulation-run-amok in our storied “laboratories of democracy” across the nation. Many state legislators have voted to limit short-term (or “payday”) lenders, either through an outright ban or through caps on the interest rates the lenders can charge. This industry has no shortage of critics, and new regulations have been popping up all over the country.

But, again, legislators have neglected to consider unintended consequences. “Payday” lenders play an important role for millions of people who may not have access to a traditional line of credit. If, for instance, a prohibitive rate cap forces these lenders out of a state, consumers in need of credit seek funds from riskier sources (e.g. loan sharks) or end up defaulting on their financial obligations. It’s no surprise that a study by the Federal Reserve Bank of New York found that states that have banned payday lenders – including Georgia and North Carolina – saw an increase in bounced checks and higher rates of bankruptcy.

The moral of the story isn’t that every government regulation is bad; it just means that the world isn’t as cut-and-dried as our political talking points make it out to be. Corruption on Wall Street and spiraling consumer debt are both serious problems that need real solutions. But if policy decisions are based on emotional arguments instead of economic facts, ham-fisted government interventions are more likely to create new problems than to fix the old ones.